The phrase Credit crunch was the start of media frenzy back in 2007 and every household felt the impact. Most people seem to think this is a new phenomenon but it was happening to Canada in the 80’s, Argentina in the turn of the millennium, and the great depression of 1929. Although, it is believed that this crisis is bigger than the Great Depression. The scale of the economic breakdown is difficult to comprehend. No previous economic crisis has involved this sum of money, in the trillions of dollars, that have been squandered by the governments to prop up the banks and financial institutions who activities have triggered the global meltdown.
Credit rating agencies have been vilified for failing to properly assess the risks associated with subprime and other low quality mortgage debt ahead of the financial crisis. They gave triple A ratings to billions of dollars of mortgages securitisations that turned out to be far riskier. The impact caused banks and investors to suffer huge losses. It goes back to 2001 when the crack started to appear after the dotcom bubble and 9/11 attacks, but the full extent did not come to light until April 2007 when New Century Financial, which specialises in subprime mortgages, filed for bankruptcy. This was the start of the domino effect. Then in July Investment bank Bear Stearns hedge funds failed to perform and banks refused to bail them out. This continued when Investment bank BNP Paribas that could not value two of its funds, the amounts of money was substantial and realisation that the banks and investment centres were financially exposed. As the German bank Sachsen Landesbank faced collapse after investing in the subprime markets and had to be sold. This spark international attention and finally the finance world were listening as concerns of various issues relating to the subprime market emerged. As news stories develop you see a compound effect.
Banks lending to banks started to drop and interest rates started to increase, attaching much higher risk values to lending. You have to ask the question, what were they thinking using short term finance to finance 25 years mortgages? Then finally on 13 September 2007 the well publicised in the press bank Northern Rock now owned by the Virgin Group had to bailed out by the Bank of England, which started media frenzy, frightened customers queued for hours to withdraw their fund amounting to £1billion in one day and finally even the average Joe off the street knew about the financial crisis.
May 2008 saw reports of more than 850 companies going into administration hitting the high street hardest, some of well known and loved shops started to disappear as the highly geared companies failed to pay back loans. Still five years on and it does not look like the end is near, shops are still disappearing as consumers are keeping hold of their money. The biggest losers in the financial crisis have been the UK and USA as small and medium sized companies fail for administration one by one, but some winners have materialised, Australian, Asian and Latin economies have emerged with clear balance sheets. The Asian economy escaped the worst of the banking sector problems. Something good that has come out of the crisis is tougher regulations on banks, but the economic profession does not come out smelling of roses. You have to wonder how did they fail to foresee the economic crisis of the noughties?
Source: Arnold, G. (2008), 'Corporate financial management'.
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